Governor for Business Magazine: The CBBH guarantees full coverage and stability of domestic currency

Senad Softić, Governor of the Central Bank of Bosnia and Herzegovina, spoke for Business Magazine about the challenges facing the banking and financial system of our country, which are caused by the new escalating global crisis, brought about by Russia's aggression against Ukraine, and by the economic war of the West and East following it.

Guided by the experience from the 1990s, when Ljubljanska banka, in the chaos of war, stole their savings amounting to hundreds of millions of convertible marks, citizens of Bosnia and Herzegovina immediately after the introduction of western economic and financial sanctions to Russia for aggression against Ukraine, rushed to domestic commercial banks for their deposits, which they also, just in case, exchanged massively into euros. Is there any reason to fear the financial collapse of BH due to the escalating new global crisis, this time caused by the economic war between the West and the East, explains Senad Softić, Governor of the Central Bank of Bosnia and Herzegovina, in an interview for Business Magazine.

BM: To begin with, can you draw the line under the pandemic crisis and tell us how successfully the Bosnian banking, i.e. financial sector as a whole has overcome it?

SOFTIĆ: In general, 2021 was marked by a strong recovery in economic activity and an extraordinary inflationary shock. According to the CBBH projection from November last year, the nominal GDP in 2021 was estimated to be at KM 37.681 billion. At annual level, the projected real GDP growth rate was 5.8 percent, which is a lower rate compared to real GDP growth in the first three quarters, according to official data from the BH Agency for Statistics, because we projected a strong price effect in the last quarter. The real sector of the economy was characterized by strong growth of industrial production, which in 2021 was significantly above the pre-pandemic level. In the reporting year, works in construction intensified, primarily in building construction, and the labour market recorded an increase in the number of employees, nominal wages and productivity. In 2021, a record collection of revenues from indirect taxes was recorded, as a result of a strong recovery in economic activity, as well as partly due to the growth of the general price level. Public investments were not allocated according to the planned programs, and the total debt of the government sector increased, which still indicates the existence of a significant fiscal imbalance in BH. As far as the banking sector is concerned, credit activity recovered in 2021, but due to extremely strong credit risks in certain market segments, credit growth is still not at pre-pandemic level, especially in the non-financial corporation sector. The banking sector is stable, liquid and solvent. Citizens' deposits are safe and there is no reason for concern. In the November round of macroeconomic projections, according to the data available at the time, we expected moderate economic activity growth in 2022 and 2023 due to the disappearance of the base effect and increase in inflationary pressure. We expected weakening of the importance of individual consumption for economic growth, and an ever-growing contribution of investments - both private and public. However, information on events and trends from the end of 2021 until mid-March 2022 indicates that the projections for 2022 and 2023 could be significantly revised in the May round of macroeconomic projections.

BM: Global and internal turbulence of far greater calibre has overshadowed Single Registry of Accounts of Natural Persons - is there anything new in this regard or are the positions still "frozen"?

SOFTIĆ: Single Registry of Accounts of Natural Persons at the level of Bosnia and Herzegovina is a reform issue and I have no doubt that it is urgently needed, but like any reform, it takes time. In the last period, as you yourself state, we are facing other challenges, so maybe some other processes, which could not be foreseen through our regular projections and plans, have been made a priority for a reason. However, BH's single payment and accounting systems are powerful tools to prevent money laundering and combat terrorist financing, and the Central Bank has all the legal and technical preconditions for establishing a Single Registry of Accounts of Natural Persons, which should and must be part of these systems. The CBBH has for many years established the Single Registry of Legal Entities Accounts and the Central Credit Registry of Business Entities and Natural Persons. Upgrading of the Registry, which would include the accounts of natural persons, would complete the long time begun process of establishing a Single Registry for Natural Persons and Business Entities. Establishing this Registry, which would be unique at the level of BH, is exceptionally important, especially now that adequate measures must be taken to improve economic activity, because it has a significant impact on the business environment in our country. In addition to being particularly important in the fight against illegal activities, such as terrorist financing and money laundering, the Registry would ease the identification of debtors' accounts in the tax and enforcement proceedings and other court proceedings, whereas the forced collection would be accelerated, and the importance of creditors protection, through timely response onto their monetary assets claims, would be manifold. For the population, this means a shorter path to the exercising of their rights in court proceedings, such as divorce lawsuits, alimony payments, enforcement and probate proceedings, and similar. On the other hand, for the banking sector, the Single Registry of Legal Entities would ensure a more efficient assets collection process. This again has benefits for citizens, because it encourages banks to lend more and on more favourable terms. Also, the Single Registry of Accounts of Legal Entities in BH, since BH exists and operates as a single economic and social space, will certainly speed up the work of security agencies, judicial and tax authorities. As you can see, the importance of this Registry is multiple and would greatly facilitate the work of all participants in the financial sector, especially banks, and indirectly the citizens of BH.

BM: In the context of the previous question, to what extent have fears been realized that bankers will be under the greatest pressure from the middle of 2021, after the expiration of temporary measures, in such a way that a large part of their loan portfolio will be at risk of falling into non-performing loans category?

SOFTIĆ: The stability of the banking sector has been maintained, even though the business circumstances for banks were uncertain in the second year of the COVID-19 pandemic. After a large decline in lending activity in the previous year, caused by socio-economic restrictions due to the pandemic, but also a new methodology for covering non-performing loans, which accelerated their write-off from the balance sheet, economic dynamics and consumption growth in 2021 contributed to bank credit growth. In any case, the amount of non-performing loans is quite low and banks can successfully overcome potential problems related to this issue, given the adequate capitalization.

BM: The pandemic period was marked by record inflation in BH - given that this is a negative trend that has affected virtually all of Europe, could we have mitigated inflation shocks and how much more severe (or perhaps easier) would they have been without a currency board? On the other hand, to what extent were the statistical indicators, that denied inflation and continuously pointed to deflation in previous years, the result of a methodological approach to the problem, and to what extent did it reflect the real situation and reliably illustrate the stability of the domestic currency?

SOFTIĆ: After fear of deflation in 2020, a significant inflation increase has been observed in the world since the middle of 2021, and the situation is similar with BH. Inflationary shock in the second half of the year was one of the main highlights of economic trends in 2021. Strong inflationary pressures in the second half of the year neutralized deflation from the first half of the year and resulted in an average rise in prices in the calendar year that has not been recorded since 2012. Inflationary pressures were further intensified at the beginning of 2022, so inflation in BH reached its highest level since the end of 2008 and amounted to 2.0 percent (average for 12 months in 2021, compared to the average for 12 months in 2020), as a result of the positive contribution of almost all sections of the consumer basket, where the growth of food, beverage and transport prices stood out. On the other hand, the negative contribution of the clothing and footwear section continued, which was the only one that had a deflationary effect on average prices in 2021. We are currently witnessing a very high rise in prices, both in BH and in the EU. According to the latest available data, the inflation rate in the eurozone is 5.9 percent, and seven percent in BH. Inflationary pressures in BH cannot be considered transitory, at least not in the short term. A significant part is structural in nature and solutions must be tied to long-term economic policies, implemented through reform processes.

Maybe the current inflationary shock in the best way shows the price we pay due to delays in implementing the necessary reforms and slowdown in convergence with the EU members. I also wish to mention that the implementation of a part of economic and all other reforms was not very demanding and did not require significant resources. Any delay proved to be a borrowing from the future generations’ standard. We are currently in a stage when short-term easing and interventions which can be done in the market of basic life necessities or one-off social aid to those most endangered would not mean much. Solutions of the problem related to inflation have to be related to long-term economic policies and implemented through a process of a number of reforms. Otherwise, productivity of domestic industries will be decreasing, making inflationary pressures increasingly stronger. At the current level of available income and demographic trends, persistent inflationary pressures will be contributing to further slowdown of convergence with the EU members in respect of quality of life. Regarding currency board arrangement, as a rule, it was introduced in the past in the countries which faced inflation problems and proved to be a good solution. Accordingly, I think that our arrangement, which enjoys complete confidence of citizens and economy, has confirmed it is justified in this situation being a guarantee of the stability of the local currency. On the other hand, it is important to put a stress on fiscal policy, i.e. budget policy in BH. There are several instruments to mitigate this global inflationary shock on the standards of households. By provisional measures, such as subsidies for the categories of population at highest risk, moratorium on excise duties, moratorium on implementing taxes on income and profit, the effect of mitigating inflationary shock can be achieved. I believe that fiscal authorities in BH would pass adequate measures, as it happened in the beginning of the pandemic, in spring 2020. 

BM: As soon as the problem related to corona virus started to disappear, a new one, which seems to be much worse started -Russian aggression on Ukraine. Have you included such kind of adverse scenario in the latest stress tests and what have they shown? 

SOFTIĆ: The war in Ukraine could not have been predicted in any stress tests. When something like this happens, all models are worthless. Unfortunately, the war in Ukraine, besides all negative things which it brings by itself, pushed the economy of Europe and the region into huge uncertainty. We managed to mitigate a shock for the financial sector, two important banks were saved, ensuring the stability of financial sector. At the meeting of the Standing Committee for Financial Stability, held on 03 March this year, it was concluded that the process of restructuring of Sberbank BH d.d.  Sarajevo and Sberbank a.d. Banjaluka was completed successfully. All the earlier risks connected with the previous owner were removed, and bank stability was preserved, protection of customers and depositors was ensured, thus keeping the stability of the entire banking system in Bosnia and Herzegovina. On the other hand, we are facing a considerable growth of energy and food prices, which has a negative impact on living standard of citizens. Urgent actions are needed to preserve the purchasing power of citizens, in order to save the country’s economic growth. Citizens should not be making unnecessary stocks of goods, as they expose themselves to unneeded costs in that way, thus contributing to the growth of prices by themselves. 

BM: Without stress tests, the economic and financial consequences of Ukrainian war will clearly be very strong, which are the largest challenges ahead of BH and the Central Bank?

 SOFTIĆ: Exposure of BH towards Russia in respect of investment is rather low compared to other countries. Foreign direct investment from Russia were decreasing in years and in 2020 end, the share of those investments was around four per cent of the total investment in BH. According to the data for the first three quarters of 2021, net inflow of direct investment from Russia was around KM 132.5 million which is around 12.6 per cent of the total inflows for that period. Net inflows of direct investments from Russia were almost entirely related to the industry of oil and oil derivatives. A part of Russian direct investments was related to banking sector. Fast reactions of regulators in both Entities proved to be timely and appropriate for preserving the stability of banking system. Regarding CBBH, in the process of investing foreign exchange reserves, it is not exposed to private or public issuers from Russia or Russian banking system. 

BM: You mentioned Sberbank several times, which was actually in the first week of the Ukrainian war, deleted from European and BH market. The public knows who has taken over Sarajevo and Banja Luka branches of Sberbank, but what has remained unclear to almost everybody is the model by which buyers were found so quickly, i.e. terms of purchase, could you explain to us briefly, how were the buyers selected “overnight”, what were the purchase prices and buyers’ obligations (or those of Banking Agencies) towards Russian Sberbank?  

SOFTIĆ: In BH, we had two mentioned banks, with majority Russian ownership structures, both as separate legal persons, not the branches of foreign banks, and both members of Sberbank Group Europe. Their joint share in the total bank sector assets in the end of 2021 was around 7.5 per cent. Operations of both banks were jeopardised by the exclusion of Russian banks from SWIFT, while their depositors started withdrawing their deposits. With purpose of preventing a negative effect on entire financial sector, operations of both banks were taken over by Entity Banking Agencies. More details on restructuring of two Sberbanks can be obtained from Entity Banking Agencies. 

BM: Branches of Sberbank were not the only ones where customers rushed to get their money fearing they would face the same destiny as depositors of Ljubljanska banka 30 years ago. What can you say about it to citizens and legal persons who are worried about their deposits? 

SOFTIĆ: We in the CBBH are aware there is a fear of citizens related to this issue, as you said, because of the experience dating back 30 years. Yet, we wish to mention that all banks in BH are members of the deposit insurance programme so BH Deposit Insurance Agency guarantees for deposits up to KM 50 thousand. Convertible mark is safe and stable, and the CBBH, with its foreign exchange reserves, guarantees full coverage and stability of domestic currency.  We have sufficient quantities of convertible mark available, and also those of euros, and we are able to meet the requests of commercial banks for cash. Citizens needs to take into account that, due to the rules on preventing money laundering, in case they decide to return their deposits which they had withdrawn by now, they can do it within one month. Besides, holding significant cash is also connected with a safety risk. Keeping money in banks is the safest.

BM: The same as the coronavirus pandemic, the war in Ukraine resulted in “revolutionary” ideas on preventive activities of the Central Bank. The BH Presidency Member, Milorad Dodik stands out again. Unlike the situation in the beginning of the pandemic, when he suggested that “excess funds of commercial banks above the reserve requirement should be released”, he is now suggesting, if I have understood it correctly, to print additional KM 800 million which would be distributed to Entities for commodity reserves, and also legal amendments on the basis of which the CBBH would be purchasing Entity securities. What is your view of such initiatives (are they serious on one hand, and potentially dangerous for country’s financial stability on the other hand)? 

SOFTIĆ: The Central Bank will continue to comply with the CBBH Law and strict implementation of the currency board. Currency board has proved to be a good anchor for BH economy and a guarantee for monetary stability. We do not support initiatives aimed at taking any reserves of the Central Bank, as they endanger monetary stability. Such initiatives occasionally appear in public, primarily for daily political purposes. Those who are familiar with monetary economy know there are no “excess reserves” in the CBBH and that each reserve has its purpose. The joint objective of holding all reserves is strengthening currency board, i.e. monetary stability as a basic precondition for development of our economy. In that respect, the Central Bank will consistently adhere to its legal mandate in achieving monetary stability. Besides, I would remind that the authorities in BH, and both Entities, when concluding Agreement with the International Monetary Fund committed not to start any initiatives related to the Law on the CBBH. 

BM: In the beginning of the pandemic, analysists announced “the worst of all recessions”, and they failed in their forecasts, and now, due to aggression on Ukraine, they mention even worse scenarios. What is your view-how expensive will be the price for Russian aggression at the global level and what will it bring to economically and financially small countries such as BH (are there any chances that the small ones could “stay below the radar” of the East and the West and have some benefits from their mutual economic conflict, i.e. to obtain loans from the IMF easier, and on the other hand ,to be some kind of privileged buyers of Russian gas as we did not impose sanctions for Russia...)? 

SOFTIĆ: It is very difficult to predict further developments. Some spectacular projections appear from time to time. Some forecasts appeared recently on possible stagflation or stagnation of growth with very high inflation in the euro area, however, only a few days later, there were statements of the officials from the European Central Bank saying that due to the war in Ukraine, a slower growth with inflation is expected, but there is no risk of stagflation. Bosnia and Herzegovina is a small, open country and it cannot influence global trends. It is forced to pay the price of global events, but we should do what actually depends on us and is within our capacities. Fiscal policy should result in measures which will mitigate a shock for the country’s real sector - both citizens and economy. We should do everything we can to help our citizens to overcome the worst effects. Those activities should be analysed, prepared, systematised and systemically implemented in entire BH as the single economic space. We urgently need calming down of political tensions in the country, regular work of state institutions and focus on actual economic reforms, those would be the strongest generators of increase of economic growth and investment cycle.